The FDIC’s unexplained decision to borrow from the Fed to resolve failed banks last spring — and the Fed’s choice to apply penalty pricing to a loan with a government guarantee — added to the banking industry’s multibillion-dollar bill.
By Jeff Huther
ABA Viewpoint
Banks subject to the FDIC’s special deposit insurance assessment recently received notification that the FDIC had undershot by 25 percent — or approximately $4 billion — its cost estimate to cover all uninsured depositors during last spring’s failures of Silicon Valley Bank and Signature Bank. That is a big miss, and it means healthy banks will get an unexpected new bill to fill an even bigger hole in the Deposit Insurance Fund.
What may be more disappointing to bankers is a new ABA analysis suggesting that a significant but undisclosed portion of the total cost to resolve the spring bank failures, up to as much as $2.5 billion, may be attributed to an FDIC decision to turn to the Federal Reserve for financing, even when it had cheaper options.
Publicly available data indicates that the additional cost is partly the result of the FDIC using the Fed as a source of funding and partly a result of the Fed imposing penalty pricing on the FDIC’s borrowing entities, despite the lack of credit risk. But the government has not disclosed additional details on the reasons behind their financing decisions, only the adjusted cost. With healthy banks picking up a substantial portion of the tab for the failures of last spring, an estimated $40 billion in total, they deserve an itemized receipt, or at least an explanation, for what appears to be a $2.5 billion penalty fee from the government.
Financing options in bank resolutions
As with any business venture, resolving failed banks requires funding. The DIF is one source, but the FDIC can rely on other sources too. Analysis of the weekly reports from the Fed and the Treasury reveals that the FDIC mainly borrowed from the Fed. The FDIC borrowed $140 billion to close the Silicon Valley Bridge Bank, $40 billion to close the Signature Bridge Bank and $60 billion to close First Republic Bank, with the total outstanding exceeding $225 billion at its peak (Chart 1). The loans have since been paid off with the proceeds from asset sales (of these banks), maturities and sales of Treasury securities held in the DIF, and a structured asset sale to the Federal Financing Bank that was later repaid.
The Fed loan was unusual — and costly relative to the FDIC’s alternatives. The additional costs have increased the assessments levied by the FDIC to cover the cost of fully insuring the depositors to SVB, Signature Bank and First Republic Bank. These assessments, and the DIF more generally, are funded entirely by banks, who in turn are paying for the decisions taken by FDIC and the Fed.
The 2023 bank failures have been reviewed by the FDIC’s Office of Inspector General, which provided critical assessments of the actions that led to the failures, including the actions of regulators responsible for supervising the banks. The reviews do not, however, examine the post-failure financing decisions. The actions described in this ABA analysis are based on assumptions using publicly available information in regular data releases provided by the Fed and the Treasury.
Unusual opacity
The source of data for Chart 1 is the Fed, which publishes a weekly summary of its balance sheet and provides a little information on the loan in a footnote:
“Includes loans that were extended to depository institutions that were subsequently placed into Federal Deposit Insurance Corporation (FDIC) receivership, including depository institutions established by the FDIC. The Federal Reserve Banks’ loans to these depository institutions are secured by pledged collateral and the FDIC provides repayment guarantees” (emphasis added).
The Fed has also provided some information on the terms of the loan in its Combined Quarterly Financial Report and a separate policy statement. The source of the large reduction in the loan in mid-September can be found in the footnote to Table II in the U.S. Treasury’s daily statement for September 15. The FDIC has not explained why it chose the Fed.
Unusual source of funding
The DIF is the usual source of funds to address bank failures, and the FDIC has statutory authority to borrow from the U.S. Treasury, the Federal Financing Bank, the Federal Home Loan Banks and commercial banks. The Federal Reserve is not on this list. The Fed does, however, have the authority to lend to FDIC-established banks. This unusual conflict of explicit authorities is the backdrop for this unusual loan.
By combining information from Treasury’s Monthly Statement of Public Debt with the FDIC’s Quarterly Banking Profile, we can see that the DIF was only slowly used to finance the sales of bank assets (see Chart 2). The FDIC’s hesitancy to use the DIF cannot be attributed to concerns about capital losses. The mark-to-market losses from the eventual sales of Treasury securities in 2023 were recognized in 2022. From the Treasury’s daily statement, we know that the FDIC used the Treasury’s Federal Financing Bank in mid-September to repay part ($50 billion) of the loan from the Fed.
The gradual reduction in the loan from the Fed was likely the result of asset sales (notably, SVB’s securities and, in late 2023, commercial real estate sales of Signature Bank assets) and, to a lesser extent, maturities of Treasury securities in the DIF. A striking feature of Chart 2 is the long time between the bank failures in March 2023 and the use of the DIF to fund those failures in the fourth quarter of 2023, reflected in the Treasury portion of the DIF portfolio at the end of the third quarter.
Unusual cost
The Fed has reported that its loan to the FDIC banks was accruing at 100 basis points above the discount window rate, but it has not explained why. The Fed stated that it lent to the FDIC under its authority in the Federal Reserve Act Section 10(B), which specifies the interest rate to be applied: “Such advances shall bear interest at a rate equal to the lowest discount rate in effect at such Federal Reserve bank on the date of such note” (emphasis added). Given that requirement, the Fed needs to explain the difference between the penalty rate applied and the statute. The Fed’s explanation should include a rationale for charging the FDIC’s entities in resolution a penalty rate for a loan that had an explicit government guarantee.
Had the FDIC exercised any of its explicit statutory borrowing authorities rather than using the Fed, it would have accrued interest at market rates, which were near the discount window rate in 2023 — that is, 100 basis points less than the cost of the Fed loan. The Fed received around $6 billion in interest costs in 2023 related to the FDIC entities. The cost of the Fed’s penalty rate was around $1 billion over the cost of using the FDIC’s explicit borrowing authorities.
An even lower cost of funding would have been to liquidate Treasury securities in the DIF in Q1 or Q2 (as illustrated in Chart 2, large amounts of Treasury securities were redeemed in Q4). The DIF’s Treasury holdings were earning less than 3 percent on its assets in 2023. The DIF had $128 billion in assets at the beginning of 2023, so it would have been insufficient to cover the entire Fed loan; however, it would have been an obvious first source of low-cost funding. Had the FDIC used the DIF and then topped off the difference with its explicitly authorized funding sources, the financing cost would have been around $3.5 billion. As it turned out, banks that contribute to the DIF ended up paying the penalty rate, which appears to have been around $2.5 billion more than use of the DIF would have been.
Debt ceiling
One possible explanation for the unusual loan could be the debt ceiling standoff from last spring. Drawing down the DIF would have required the Treasury to increase its bill issuance to cover the cash outflow, a step it may have been reluctant to take during the Spring 2023 debt limit impasse. This reluctance, however, would have been due to optics rather than substance, since liquidation of the DIF’s holdings of Treasury securities reduces the amount of Treasury debt outstanding, making an increase in Treasury bill issuance to offset the cash outflows debt-neutral.
When SVB failed, the Treasury’s cash on hand had already been reduced by the failure to raise the debt ceiling, so turning to the Fed for a very short-term loan could be understandable from a cash management perspective. Still, the FDIC had other options. While the FDIC’s ability to exercise its line of credit with the Treasury may have been limited by the debt ceiling debate, the agency’s ability to convert its DIF holdings of Treasury securities to cash remained in place.
The Treasury usually has short-term borrowing needs in March (from tax refunds and paydowns in debt in anticipation of the mid-April tax filing date). Market participants anticipate additional Treasury bill issuance each spring. Had the Treasury needed to raise additional cash, it could have done so within three or four days by issuing a cash management bill or within a week using regular bill issuance.
It is also possible that officials were concerned that a change in DIF composition would have been seen as undermining confidence in FDIC solvency, although it is difficult to see how using the DIF for its intended purpose would have been interpreted as anything other than appropriate. It is also difficult to see how a more aggressive effort to pay down a Fed loan with onerous terms would be viewed as anything other than good stewardship of the DIF.
Conclusion
The FDIC’s 2023 loan from the Fed was a highly unusual source of funding that came with eye-popping penalty pricing on banks compared to other available alternatives, based on the publicly available information. As the steward of the DIF, the FDIC owes the banks that pay into the DIF an explanation for its funding choices, and the Fed owes the public an explanation for charging a penalty rate for a loan with an explicit government guarantee. Banks, not taxpayers, covered the bill for last spring’s bank failures. They have very legitimate reasons to want to understand how the government arrived at the final price tag.
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